"Systemically Important" FSOC Faces Ire: Keep Buying Big Funds

The Financial Stability Oversight Council was formed in Jul 2010 to assess risks to the U.S. financial system. These risks were ideally posed by distressed or large interconnected bank holding companies or non-bank financial companies. As the 2008 recession crushed the "too big to fail" myth, this oversight body was formed to protect from risks or wipe out the misconception.

Perhaps in doing so, the body had picked on certain bellwethers and stated they were "systemically important." But this spelled trouble for FSOC, which was established by Title I of the Dodd-Frank Wall Street Reform and Consumer Protection Act. FSOC had identified MetLife (MET) as a "non-bank systemically important financial institution" last year, but the insurer sued FSOC for that. What we are more bothered about is that the board's contemplation to designate the biggest asset managers as "systemically important" hasn't gone down well with top fund managers.

FSOC Face Ire

In a recent turn of events, Republican lawmakers bashed FSOC calling it 'secretive and unwilling to share information'. Also, House Financial Service Committee Chair Jeb Hensarling criticized FSOC's scheme of picking certain mutual fund companies or other asset managers as "systemically important." He mentioned that this will eventually lower returns for investors.

Last Tuesday, the FSOC, for the first time, had to testify before the House Financial Services Committee as a group. While debate on the existence of "too big to fail" institutions still do rounds, there are also debates about the ways of the FSOC. Moreover, Dodd-Frank supporters say that the legislation is to stop tax-payer funded bailouts to these large institutions. The counter argument is that the law codifies these institutions by allowing FSOC to term them as "systemically important." The way this designation is given is also highly debatable.

Eight out of 10 council members testified, but they said they can't share information about how they monitor banks as this is "non-public". New Jersey Republican Scott Garrett said: "You need to become more like us - more transparent, more open to the American public". Wisconsin Republican Sean Duffy too had urged the council to inform how they designated MetLife, General Electric and American International Group as systemically important financial institutions.

This "non-public" method of designating certain institutions as "systemically important" is being questioned. Jeb Hensarling said, "Of all of the Council's activities, none generates more controversy than its designation of non-bank financial institutions as 'systemically important financial institutions,' or SIFIs. Designation anoints institutions as Too Big to Fail, meaning today's SIFI designations are tomorrow's taxpayer-funded bailouts."

Hensarling also went to state that designating a particular institution gives the Fed virtually complete control over their management. This leads to a large portion of the economy coming under direct government control.

FSB Concerns; Fund Houses Protest

Previously, Financial Stability Board (FSB) had contemplated designating the biggest asset managers as "systemically important." However, as we had reported earlier, the possible rules to treat bellwether US fund managers like Fidelity and BlackRock as threats to the financial system were criticized. Fidelity's attack on FSB was joined by Vanguard Group. They echo other fund managers' claim that global financial regulators' ways to identify too-big-to-fail investment funds were deeply flawed.

Mark Carney, chair of FSB, said the risk on investors runs on "funds that offer on-demand redemptions but invest in less liquid assets." A report by Financial Times notes that the regulators are "looking at the stability impact of securities lending by asset managers, and the complexity of fund businesses structured as holding companies, which bear a growing resemblance to banks."

Also, the FSB and International Organization of Securities Commissions had suggested framing tougher rules in March. They believe the asset managers' failures may "cause or amplify significant disruption to the global financial system."

In protest, Vanguard stated that the approach is toward forming 'entity-based designations rather than addressing systemic risks'. Identifying asset managers and funds based on their size is "both overinclusive and underinclusive." They also argued that size, which is not a proxy for risk, can be manipulated.

In 2013, Vincent Loporchio, a spokesman for Fidelity, had said, "We continue to believe that the asset-management industry, and mutual funds in particular, do not present the types of risk that the FSOC was designed to address."

Invest in Funds without Concern

Investors need not be perturbed by the whole "too big to fail" or the "systemically important" fiasco. The oversight body is now caught in a situation where its transparency is being questioned. In fact, Securities and Exchange Commission Chair Mary Jo White commented that FSOC should not instruct firms on how to run their business.

Designating certain fund houses may be tough in the near term. The FSOC is already fighting a legal battle with MetLife now. So, keep investing and profiting from the favorably-ranked large-cap funds from these bellwethers.

Below we highlight 3 mutual funds each from Vanguard, Fidelity and BlackRock fund families that carry a Zacks Mutual Fund Rank #1 (Strong Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors toward potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on its likely future success.

These funds have at least $250 million of total assets. They have encouraging year-to-date and 1-year total returns. The 3- and 5-year annualized returns. The minimum initial investment is within $5000.

Vanguard Health Care Investor ( VGHCX ) invests a major portion of its assets in securities of companies primarily involved in operations related to the health care domain. VGHCX invests in health care companies including pharmaceutical firms, medical supply companies and companies engaged in operations related to medical and biochemical. VGHCX may invest a maximum of half of its assets in companies located in foreign lands.

VGHCX has gained 11% year to date and 10.7% over the last one-year period. The 3- and 5-year annualized returns are respectively 26.4% and 21.6%. This Vanguard fund has $51.73 billion of total assets under management. Annual expense ratio of 0.34% is lower than the category average of 1.33%.

Fidelity Select IT Services Portfolio ( FBSOX ) invests the lion's share of its assets in common stocks of companies that provide information technology services. FSBOX invests in securities of both U.S. and non-U.S. firms. While selecting investments, FSBOX uses fundamental analysis of factors looking into the issuer's financial condition and industry position along with the economic and market environment.

FBSOX has gained 15.2% year to date and 18.2% over the last one-year period. The 3- and 5-year annualized returns are respectively 23.7% and 17.9%. This Fidelity fund has $2.09 billion of total assets under management. Annual expense ratio of 0.81% is lower than the category average of 1.43%.

BlackRock Science & Technology Opportunities Investor A ( BGSAX ) invests the majority of its assets in equity securities issued by domestic and foreign science and technology companies. BGSAX may invest a maximum 25% of its net assets in emerging economies. BGSAX generally invests in common stocks but may also invest in preferred stocks and convertible securities.

BGSAX has gained 11.4% year to date and 15.6% over the last one-year period. The 3- and 5-year annualized returns are respectively 21% and 10.7%. This BlackRock fund has $289.4 million of total assets under management. Annual expense ratio of 1.59% is higher than the category average of 1.43%.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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